OFG - OFG Bancorp: Strong Net Interest Income Growth On The Cards

• Puerto Rico's heightened economic activity and low unemployment rate bode well for loan growth.
• Sticky deposit costs will enable net interest income to benefit from a rising interest rate environment.
• Provision reversals will likely normalize this year. Nevertheless, net provisioning for this year will remain below the historical average.
• The December 2022 target price suggests a high upside from the current market price. Further, OFG is offering a decent dividend yield.

Earnings of OFG Bancorp (NYSE: OFG ) will most probably surge this year on the back of strength in the Puerto Rican economy, which will lift loan balances. Further, the net interest income, which is moderately sensitive to rate changes, will benefit from the rising interest rate environment. On the other hand, a normalization of loan loss reserve releases will limit earnings growth on a year-over-year basis.

Overall, I'm expecting OFG Bancorp to report earnings of $3.07 per share for 2022, up 9% year-over-year. Compared to my last report on the company, I have revised upwards my earnings estimate because of upward revisions in both loan and margin estimates. The year-end target price suggests a high upside from the current market price. Therefore, I'm maintaining a buy rating on OFG Bancorp.

Puerto Rico’s Economy to Drive Loan Growth

OFG Bancorp’s portfolio grew by 1.9% in the first quarter of 2022, or 7.6% annualized, which surpassed my expectations. The outlook for loan growth remains rosy mostly because the Puerto Rican economy is continuously going from strength to strength. The region's economic activity index was up 3.5% year-over-year in April 2022, according to the Economic Development Bank of Puerto Rico.

Moreover, Puerto Rico's job market has continued to improve. The unemployment rate has dropped to only 6.2%, which is near multi-decade lows.

The management also appeared optimistic about the loan pipelines and line of credit utilization in the latest conference call . Considering the economic outlook and the apparent on-ground strength, I'm expecting the loan portfolio to increase by 5.0% by the end of 2022 from the end of 2021. In my last report on OFG Bancorp, I estimated loan growth of only 2.0% for 2022. I have revised upwards my loan growth estimate because of the first quarter’s surprising performance as well as an improvement in the economic outlook for Puerto Rico. The following table shows my balance sheet estimates.

In my last report on OFG Bancorp, I estimated earnings of $2.84 per share for 2022. I have now increased my earnings estimate because I have revised upwards both my loan and margin estimates.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, the threat of a recession can increase the provisioning for expected loan losses beyond my expectation.

High Total Expected Return Warrants a Buy Rating

OFG Bancorp is offering a dividend yield of 2.3% at the current quarterly dividend rate of $0.15 per share. The earnings and dividend estimates suggest a payout ratio of 19.5% for 2022, which is close to the five-year average of 22%. Based on the payout ratio, I believe OFG Bancorp will not increase its dividend again this year.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value OFG Bancorp. The stock has traded at an average P/TB ratio of 1.13 in the past, as shown below.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $20.5 gives a target price of $23.2 for the end of 2022. This price target implies a 10.0% downside from the July 1 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $33.6 , which implies a 30.6% upside from the current market price. Adding the forward dividend yield gives a total expected return of 32.9%. Hence, I’m maintaining a buy rating on OFG Bancorp.

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